November 21, 2012; The Transformation of War

Kevin: David, we are seeing the bombs fly right now in Israel. I know you were in Israel just last year, but wars these days seem to be fought without large armies and without actual front lines. We have bombs being lobbed in the very homeland, and they are coming right from residential areas. We have Hamas, we have Hezbollah, we have the Muslim Brotherhood to the south. It is so hard now to distinguish, because we are not necessarily talking about countries, we are talking about small groups fighting each other.

David: When I was in Israel, we spent some time in Jerusalem and an afternoon, actually, with Martin van Creveld, who is there in Jerusalem in one of the settlements just outside. He is based there, and teaches at Hebrew University. He is a military historian. It has been suggested by many of his colleagues that he is, perhaps, one of the greatest military historians in the last 100 years, and maybe even beyond that.

There is this idea, in one his books written in the 1990s, that warfare is returning to an earlier iteration. The state, as we know it, is a fairly modern convention, and state warfare along with it is also modern, dating from the 1600s and the signing of the Treaty of Westphalia. Following that period, conflict was controlled more and more by a professional, state-run military, and that era of direct conflict, in van Creveld’s view, is now changing.

We have terrorism, we have regional conflicts, we have warlords, we have drug cartels, we have smaller-scale conflicts which are based on ideology, based on turf fights, or based on other issues, but frankly, these things dominated the scene and were the picture of conflicts prior to 1648, and they seem to be returning.

Kevin: David, in this day and age, it used to be, look at the James Bond films from back in the old days. It was Russia, and it was America. It was giant superpower fighting giant superpower. Maybe it was espionage, maybe it was nuclear, but nonetheless, they were nameable state entities, and at this point we just have to continually read the Jerusalem Post, Al Jazeera, The New York Times, just to keep up with the various groups. It is hard now because the enemies are showing far more ambiguity, are they not?

David: Exactly. Naming the enemy, facing the enemy, defeating the enemy. These are goals which now have much more inherent ambiguity, and the direct conflict between superpowers is far less likely in the decades ahead, at least in that traditional mode of conventional conflict. From the credible analysis we glean a number of things, including that the weapons of choice in future wars are not necessarily nuclear or otherwise conventional, but they require the mindset of a guerilla fighter to undermine, destabilize, shift the balance, as in jujitsu, and gain advantages by hitting where they least expect it. You recall Jonas Savimbi?

Kevin: Oh sure.

David: He was a man who was an avowed communist, trained for years in Maoist guerilla warfare, with the Chinese in the 1960s, before disavowing communist ideas in the mid 1970s, and then leading a civil war against the Soviet-supported MPLA in Angola. From 1974 to 2002 when he died, UNITA, the fighting force led by Savimbi, continued in that sort of conflict that van Creveld described, and whether it is civil wars in Africa or Asia, or the rising trend of religious-inspired terror throughout the world, we have non-conventional warfare which is appearing and appears to be with us and here to stay, really.

Kevin: David, wouldn’t you say that Al Qaeda is just one of the few names that we can actually point at and say that is maybe an enemy?

David: If you wanted to put a face to it, Bin Laden is probably the closest we come to putting a face to the enemy, if fighting and winning is for us, today, the same sort of challenge I think the British faced over 200 years ago, when the colonists simply wouldn’t stand still in an orderly line and wait to get shot at by that overwhelming host of redcoats. Today, certainly, technology gives us an advantage. Without technology as an edge, we might have to revert to techniques and strategies and the sheer numbers that the British relied on so heavily.

Kevin: David, it’s not just countries, it’s not just small groups or states, and it’s not necessarily these religious groups that are always the enemy. With corporations, themselves, right now, it’s hard to define their borders. It’s not just an American corporation these days, or a European corporation, that’s investing worldwide, and using many currencies and many different types of financial mechanisms.

David: We have had multinational corporations for decades, even during the cold war, but there is something that is very unique since the end of the Cold War – multinational corporations which are really stateless, or state political entities, along with state-sponsored enterprises. Those are the companies that are owned and controlled by various governments. In Russia you have Gazprom. In China you have Sinopec. And then lastly, sovereign wealth funds. These are the organizations that are operating international businesses according to a set of rules which has also changed.

Kevin: David, the way we would normally see a corporation is just trying to capture market share, McDonalds competing against Burger King, for example. But what you are saying is that these state-owned corporations, or these multinational corporations that have other goals may actually be cornering strategic types of investments, commodities. They may be manipulating things in markets for other reasons than just capturing normal traditional market share.

David: This is where business and politics is creating ambiguity once again. Capturing market share is the normal evolution of a business enterprise, but now we have enterprises that are capturing more than market share, such as strategic mineral reserves, or software that provides a crippling edge to the competition. Who is the competition? Is it a corporation, or is it another country?

When we are talking about state-owned enterprises and corporate growth, what exactly defines corporate growth and the boundaries of corporate growth when we are really talking about the government behind it that has intentions and a program in place? Technology, in the form of hardware and software – these are both weapons that can be used by state and non-state actors alike.

We used to fight wars for natural resources. We fought to control natural resources. Now we ask a corporate executive in a boardroom to buy those interests and consolidate them into a balance sheet, which is often supported by cheap credit, or some other such subsidy, and of course, there are others that might decry that as an unfair advantage.

But frankly, everyone is doing that. As we said, China has Sinopec. France has EABS, the aircraft and arms manufacturer. Russia has Gazprom. The U.S. has G.E. and Citigroup. These are all corporations which receive direct and indirect support from the government. They are truly corporations, but they are also truly enmeshed with political ends. They are, unfortunately, corporatists, or dare we say, fascists? And it is, today, a universal game. It is not just one country where you see this happening.

Kevin: This reminds me a little bit of what we have seen over the last couple of years between Israel and Iran. We have corporations that are manufacturing equipment that enriches uranium, yet the software was tainted somehow, via espionage, so that the equipment would have a virus right at the critical moment. We have seen that this is another form of warfare.

David: This is where the lines are blurred, the lines between corporate espionage and espionage in general. Look at who makes up a multinational corporation today. These multicultural teams bring the requisite cultural, linguistic and professional expertise to a very effective management program for a global organization. These are citizens of the world. They are very cosmopolitan, they are open-minded.

And yet we have these conflicts between companies that are sponsored by states, sovereign wealth funds, which have a very specific role, investing toward the interests of the state, and multinationals, these sort of stateless, apolitical organizations. When you take a secret from one group, who are you taking it for? Who does it benefit? Are you a citizen of the world, or are you a citizen of your home country? This is, again, where we live in ambiguity.

We are, today, reflecting on the possible vulnerabilities opened up in this post-modern age, and I think it is important that we remember the nature of mankind. We might find a naïve mindset as a vulnerable posture for our country, or frankly any country.

Let’s pretend that all states are signing on for peace on earth, goodwill toward men. Even if that were the case, then we could assume the best from multinational corporations, of state-owned enterprises, of sovereign wealth funds. We still have the Russian mafia. We have global crime syndicates, dressed today, frankly, to match the profile of an investment banker. We have warring drug lords and drug interests that are fighting and organizing themselves like military forces, banking with HFCC no less, and other banks, and coming into and out of our country with relative ease. We live in a very interesting age where conflict, whether it is economic, financial, or actually military, is, as van Creveld suggested, not just oriented to the state and the military.

Kevin: David, I think you were talking about a naïve mindset, and yes, we would all love to have peace on earth. I think about the naiveté of the bumper sticker that we often see that says, “Co-Exist,” and it has all these different religious symbols that historically have not gotten along together. But there is always a back-story, and unfortunately, man’s nature is not necessarily always good-natured, as we know. Capturing market share may feel like a soft invasion, but it’s an invasion, nonetheless.

David: Whether is it capturing market share, or mergers and acquisitions, gaining vital resources or technology, this is really like a strange time warp. If you go back to the Asian conflict and what we saw during the Vietnam War, [garbled] was running a series of legitimate businesses, but as a cover-up for CIA operatives in the area. Starting a revolution in Central America – this has happened in recent history. We started a revolution in Central America so that certain construction crews could get a contract, versus the competition.

Kevin: Look at the Panama Canal.

David: Exactly. That’s how the Panama Canal was built in Panama. It wasn’t supposed to be there. Long live the revolution!

Kevin: We live in a day and age of technology, and even for those people who are fighting technology, or seem to hate technology, they are actually using it as a weapon right now.

David: Right. We have the Iron Dome, which is spinning off rockets, and this is a very complex technology that the Israelis are using to defend against a bombardment of rockets. Again, these are conventional weapons, used unconventionally. I say unconventionally because they are launched from civilian areas. Over 1200 of them have been launched and knocked out.

What is interesting, though, is that side-by-side we also have a technological attack. Israel, from November 14th to the 18th, has fended off 44 million different computer attacks, with only one virus disturbing its systems – 44 million attacks in about a five-day period. It runs the gamut from enviro-anarchists and radical Jihadi groups alike. They see technology, ironically, as a tool with which to cripple the system and return it to a simpler time.

Again, whether it is the conventional warfare, or the unconventional warfare, technology is an interesting means to that same end. There is a second battle raging at the same time which can freeze communication systems, destroy the banking sector, and with it, the economy.

Kevin: The day of having the little toy soldiers, the ones that were painted blue, and the ones that were painted red, and positioning them around on the battlefield to pretend that you are working through different strategies – it’s far more complex than that, at this point. We are talking about 44 million cyber attacks, or viral attacks, toward Israel over the last few days. Those have had to be fended off because you can’t fight a war without technology these days, and you can’t have technology without communications and the computers all working. Really, it’s a change from a military standpoint. Would you say that there are other things that are being used right now in the form of warfare that no one really even senses from the old study of battlefield tactics?

David: Absolutely. I think this is under-appreciated, but it is just as critical to the U.S. economic and political viability, moving forward, if you consider economic and financial warfare. Benjamin Franklin wrote about the attack on America, coming from the British, in an attempt to destroy the fledgling nation’s economy and to cause social unrest. The Continental currency was issued during the revolutionary war and was vital for the Continental Congress as a means of financing the war effort. There was reasonable, but not over-, issuance of the currency, and, lo and behold, a great inflation broke out anyway.

Why? Because of massive counterfeiting on the part of the British. The British were hoping to destroy the support of the war effort by causing economic dislocation and pain that Americans would thus associate with the war effort, versus the alternative of living at peace with the British. It is amazing, because the British used the same tactic during the French Revolution to further destabilize the powers of the day, the French Revolution, the American Revolution. In France they were counterfeiting assignats and adding to inflationary pressure in France.

Kevin: This is nothing new. It has gone on, obviously, for hundreds of years, where you try to destroy your enemy with some sort of currency manipulation, but look at what is going on right now. We talked about Iran and Israel, but actually, between Iran and the United States, this is not just a concern about a nuclear buildup, this is a concern about a currency war.

David: Right. You can use a currency to either gain a strategic advantage or to destabilize a regime, and we are fighting this fight with Iran as we speak. We are not merely attempting to limit trade with a rogue nation, but we are hitting them where it matters the most. All assets in Iran are priced in the real. If you can cause a crippling run away from the real, a decrease in purchasing power of 60%, or 300%, it has been radical.

If you look at 2012, there has been an absolute financial slaughter in Iran. In a matter of months, we have targeted not only the policy shifts, but ultimately regime change, and it is as if we are living out the British role. We are asking to keep nuclear stability in play. We are acting the British part, and today, maintaining dollar stability, U.S. political hegemony, but it is via the destruction of the real.

Kevin: David, last week, and this was so critical, you talked about how faith in a currency is really the only thing, once it is a fiat currency, that gives it any value in the first place. When you shatter the faith, that is, of course, when you go into that incredible devaluation of the currency that we could also call inflation, or hyperinflation.

David: Right. Past tense, currencies have been, and will continue to be, used as weapons. Current tense, they are being used, right under our noses, and they are being targeted for their inherent vulnerability. Mind you, it is fiscal chaos, and granted, we have created some of that fiscal chaos in Iran, but if you look at home, we have our own bout of fiscal chaos. It is fiscal chaos in that environment, that is a very good environment into which you can launch an attack on currency, because legitimacy and trust are already on the minds of investors, whether domestic or international.

We are talking about currency-holders, and that is a very weak point to hit on. It takes a lot less energy to start an avalanche when the hillside is already loaded with snow. That is the environment the U.S. is in today. We have massive fiscal imbalances, and it wouldn’t take much, if an enemy wanted to press the advantage, to create currency instability.

Last week we discussed the demand dimensions of inflation, that is, when a currency is repudiated, no one wants it anymore, demand goes away. Getting rid of existing dollars or any other currency – it doesn’t have to be the dollar, any currency you have, it has the same effect. Getting rid of those units has the same effect as printing new ones.

Kevin: So, when Milton Friedman said that inflation is a monetary phenomenon, that’s not necessarily the case. It may be a supply-and-demand phenomenon.

David: In this case, we are really talking about psychology being the defining factor in super- and hyperinflation. So Friedman was wrong. Inflation is not always and everywhere a monetary phenomenon. It is, unless it is a psychological phenomenon in which people are getting rid of the stuff. One minute things are fine, and the next, they are not.

Kevin: In my lifetime here in the United States, I have never experienced a hyperinflation. Give us an example of what you are thinking about right now.

David: This is just a perception change, but let’s say, for instance, I have a billion dollars on deposit with J.P. Morgan. As a deposit, that supply of dollars is not causing inflation. But let’s say that I wake up tomorrow and I realize that the Fed, which has worked effectively in its 99 years of existence, has worked for 99 years to destroy my purchasing power. Next year is its 100-year anniversary. This is a new realization for me somehow. 95% is gone since 1913. What used to cost one dollar now costs twenty dollars, and I decide to spend as much of it as I can before the Fed has the privilege of taking my last nickel. In the case of a billion dollars, it’s not just a nickel, but again, we are speaking in terms of purchasing power.

Kevin: Right.

David: When I purge the bank account and start buying things, businesses are glad I’m in town, spending like a billionaire on a mission. They may realize later that I knew something that they did not know and that what I have transferred to their accounts is something with a half-life. If they don’t get rid of it quickly, it will be worth less when they unload it, and their balance sheet, their bank account, will take the loss. At least I have something material to show for the billion dollars that I just spent.

Kevin: David, what you are talking about is a personal decision to do what you are doing, but actually, is this not mass psychology? It’s not me or you, necessarily, that is creating inflation when we decide to get out of that particular currency. It is when we do it, and our neighbor does it, and their neighbor does it, and it just builds on itself.

David: And demand is the variable that reflects mass psychology finding a tipping point. What is the cusp event? What alters how people view a currency? Official money-printing may be the culprit, but a real inflation begins, not when money supply is growing exponentially, but when people’s confidence in the paper in question, and the government backing it, is in collapse. As we said last week, when demand works in reverse, and all dollars currently in existence come out of accounts, velocity explodes higher, and the game of hot potato begins.

Kevin: This reminds me of the book by Adam Fergusson about the 1920s and hyperinflation in Germany, the book, When Money Dies. It seems like that is the phenomenon that occurred at that point. It became a mass run to the door.

David:When Money Dies is the story of the German mark being destroyed by a private banker. Recall that Havenstein was a private banker, and he had a bad idea. But more than that, it’s the story about a shift in sentiment. Inflation began to boost the value of all things, and it is interesting that stock investors were pleased by this initially, not realizing that massive money-printing was causing a repricing of goods and services, it was not just their sheer brilliance as investors. Things were getting not more expensive, but the other way of looking at that is, paper itself was becoming worth less and less, so it took more money, more paper, to buy the same things.

The issue in play is really one of strategy, and this is bringing us full circle. How do we defend our currency? Having the reserve currency status that we have, the U.S. dollar, and leading, as the world’s largest economy, is not something that we get to keep by default. We were once far less powerful, and we can move back to that place again.

Number one, we need to continue exploring the idea of a return to a gold standard, putting a bullet-proofing around our currency, and thus, our economic trajectory here in the U.S.

Secondly, we also need to consider the implications of an attack on the U.S. dollar, and how we can adequately defend against it. Currency wars are more common than you think, and I’m not sure that the Pentagon really understands just how vulnerable their counterparts in D.C. are making us, via the debts and deficits that we are accruing.

This is, again, the point being that no one will attack the U.S. dollar if it is strong, but if we are in a moment of weakness, it doesn’t take as much to push, and if we are in a state of national imbalance, for us to topple at that particular point.

Kevin: This really reminds me of back in the 1990s when George Soros benefited, by 2 billion dollars, betting against the British pound. One could say that was just a good bet, or one could say that actually was a form of currency war.

David: When a domino is falling, it doesn’t take much to help it go a little faster and a little bit further. The physics, the dislocation, were in play, and that’s what Soros was capitalizing on, something that was out of balance, out of kilter, to begin with. It could not be maintained indefinitely, and it reached that point of natural dislocation, and he was there to bet against it, and profit from it.

You could argue the same thing will ultimately happen with the Swiss National Bank. The Swiss National Bank is spending a lot of money to intervene in the currency markets, and peg the Swiss currency, the franc, to the euro, so that they don’t lose a trade disadvantage, so that they can continue to sell goods from Switzerland, into larger Europe, without being priced out because their currency is getting expensive, and thus, the goods that they manufacture and export are too expensive for the European marketplace.

The European marketplace is far too important to the Swiss, so what are they doing? They are fighting their own fight, they are fighting their own battle, manipulating their own currency lower, so that they can keep jobs in play.

What happens is quite simple. If you lose a trade advantage, you begin to see factory closures. With factory closures come higher unemployment. With higher unemployment comes political destabilization. Ultimately, politicians look at using currency as a tool to fight their competition, not because they want to see companies do that much better, but because they can’t afford to have more people enter the ranks of the unemployed.

The unemployed represent potential energy. Potential energy, as China has discovered over the last several hundred years, is a powder keg. There have been so many revolutions, so many riots, so many street protests, in China over the last 300 years, and even over the last three months. These are countless, and frankly, guess why we don’t hear about them? Because they control the media, and that’s very important. They don’t want that to spread like wildfire. It may anyway, but governments always want to keep people fully employed, fully preoccupied, so that they cannot be unhappy, disaffected, and rioting in the streets.

Kevin: David, you are talking about unemployment being so important. Of course, all states want to stay in power, and I’m including China in this. We have talked about the outgoing China General Secretary, Hu Jintao. He has been replaced at this point, but he did have a very critical statement about the Chinese currency and the American currency, as he was leaving.

David: Yes, it was basically that the current international currency system is the product of the past, and there is a growing audience of people who see dollar-supremacy and monopoly status as something that has to go. How does that happen? Is it a gradual process? Does it happen all at once? We will have to find out, but you can already see cracks in that monopoly status emerging over the last ten years.

We have seen the euro appreciate from 0.99, basically 99 cents compared to the dollar, to 1.59 by July of 2008. As a reserve asset held by central banks, it has gone from 0% of their total allocation, to over 24% of all central bank foreign currency reserves. In the wake of the Great Recession, now we have seen the price of the euro drop as much as 30%, and, lo and behold, China and other key trade partners have helped stabilize the euro.

Declining European purchasing power puts limits on further imports from China. China, not wanting to see trade partners’ demand for goods change, has helped prop up the currency. So there is this effort to solidify the euro’s role in the international monetary regime, open up regional opportunities for the yuan, and ultimately, take the dollar down a notch, or maybe it just takes a step back.

But the future monetary regime will, in most people’s opinion, better reflect world trade and the key trade partner relationships, and not be so centered on the U.S. dollar. As that happens, what we are seeing is, essentially, what people would describe as a race toward the bottom – competitive currency devaluation. Everyone wants their piece of the export pie, and if they are going to keep that competitive edge, politicians will look at it in easy terms. Devalue the currency, yes, but ultimately there may be long-term inflationary effects, but devalue the currency today, maintain the competitive advantage in terms of trade and export, and you keep people employed.

Jobs equal political stability. You tell me what a politician cares more about than their own personal legacy and place in policy and in politics. Jobs are paramount. I think we are going to see a lot of that over the next four years here domestically. We have the balance of power shifting from the halls of finance to the halls of politics. And the political agenda we see is set.

There are grave currency consequences for that here in the United States, but managing the dollar lower is ultimately going to fly in the face of what Tim Geithner said only a few years ago. “We want to see a strong dollar.” He said that in the context of the dollar taking about a 10% hit. Was it just a matter of him talking out of both sides of his mouth? Absolutely. They will talk strong dollar language, when in fact, they are doing the exact opposite – waging a war to gain an advantage, to employ more people, and to return to being manufacturing-oriented, our economy having much more of a manufacturing base.

Frankly, I don’t think we can get that done. I really don’t think we can get that done, even if we destroy the dollar. But that is not going to keep academics and politicians from attempting it.

Kevin: Talking about academics and politicians, going back to the 1970s, you and I have both been very critical of the dual mandate of the Fed. Of course, the mandate of the Fed is to keep inflation low and unemployment low, but we realize that a lot of times the tool used to try to gain employment in any country is to print money. I guess if you were the Federal Reserve Chairman right now and you had a politician standing over you, you would probably opt for inflation and the destruction of your currency before you opt for high unemployment.

David: There is this drive by the Fed to create an environment of negative real rates in hopes that they can take bank deposits – we talked about the billion dollars that I theoretically have on account with J.P. Morgan, and trust me, it’s only theoretical, it’s just an example, pie-in-the-sky. But again, if the Fed can force deposits, whether it’s mine, whether it is bank CIOs and CFOs who are sitting on 1.7 to 1.8 trillion dollars in cash, if they can drive that money into the economy, they are going to try to do that.

And the zero interest rate policy, and the inflationary policies that they have put in play, are intended to do just that – punish you for seeking safety. They want you to get out into the marketplace, spend it, invest it, do something in the stock market, do anything but keep it lying dormant on account.

Kevin: David, I can’t control what is going on in Israel, and you can’t either. We can’t control the currency wars between China and the United States, and Europe, and Iran. One of the things we can do, though, is to continue to make active decisions based on this analysis for our own families. David, can you offer some suggestions as to what people should be doing right now?

David: The game that is being played, and whether you realize that you are a rat in a maze or not, you need to recognize that. The Fed would like to push you into the marketplace, and with savings, with hard-earned dollars, the blood, sweat and tears, the toil of your work effort, and the savings which represent that work effort, the Fed would like you to get out and spend it, as a consumer. Go buy consumer electronics, go buy the new iPad, go buy anything to stimulate growth in the economy. They need you to prop up aggregate demand, because frankly, they’re not doing a very good job.

The problem is this: They are trying to create an environment of fear of inflation and get you to go out and spend. What you should be doing is investing in the right places, something that gives you that Teflon coating, that as we experience higher rates of inflation, you have protection in your portfolio.

That is the legacy of gold. That is the legacy of silver. That is the role that precious metals play, ironically, both in an inflationary environment, and particularly gold in a deflationary environment, as an asset protector, as an asset preserver, as the guarantor of purchasing power.

If we go back to that earlier example, from 1913 to the present, and my one dollar, now I have to spend twenty dollars to buy the same thing. That’s not the case for someone who has owned precious metals. During that whole period of time, from 1913 to the present, you have been able to maintain purchasing power. Has it made you wealthy beyond the dreams of avarice? No, it has just maintained your purchasing power. An ounce of gold has always bought roughly 300 loaves of bread. It did in 1913, and it does today.

Kevin: David, as a preview of coming attractions, I think we should continue to explore our vulnerabilities, not only with currency wars, but just as the nature of the state is changing. And of course, we will have guests on that will add to that conversation.